Approximate Equilibrium Asset Prices
AbstractThis paper reconsiders the determination of asset returns in a model with Kreps-Porteus generalized isoelastic preferences where returns appear governed on the basis of Euler equations, by a combination of the two most common measures of risk -- covariance with the market return and covariance with consumption. To go beyond Euler equations and to take into account the links that the consumers' optimal behavior establishes, through a budge connstraint, between market returns and consumption, we derive an approximate consumption function (obtained, as in Campbell (1994), by log-linear approximation). Arguing that total consumer wealth is unobservable, we use this consumption function to reconstruct from observed consumption data i) the wealth that supports the agents' consumption optimal income, and ii) the rate of retun on the consumers' wealth portfolio. This procedure enables us to derive formulas that (approximately) price, in the tradition of Lucas (1978), all assets as a function of their payoffs and of consumption. The generalized consumption CAPM that we obtain is derived for both homoskedastic and heteroskedastic consumption processes. We also use our approximate pricing kernel to highlight the crucial role of temporal risk aversion in the determination of the equilibrium term structure of real interest rates.
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Bibliographic InfoPaper provided by Sciences Po in its series Sciences Po publications with number 6611.
Date of creation: Jun 1998
Date of revision:
Other versions of this item:
- Fernando Restoy & Philippe Weil, 1995. "Approximate Equilibrium Asset Prices," Banco de Espaï¿½a Working Papers 9515, Banco de Espa�a.
- Fernando Restoy & Philippe Weil, 1998. "Approximate Equilibrium Asset Prices," NBER Working Papers 6611, National Bureau of Economic Research, Inc.
- Fernando Restoy & Philippe Weil, 2011. "Approximate Equilibrium Asset Prices," Sciences Po publications info:hdl:2441/5l6uh8ogmqi, Sciences Po.
- E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
- G0 - Financial Economics - - General
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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